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IIM CalcuttaJulySeptember, 2010
Sources of Long Term Finance
DR. U. K. BASU
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Source of Finance
How much of Long Term ProjectFinance and How much of Short
Term Working Capital Finance?
Project Cost and Means of Financing
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Project Cost
Project Cost for any Project includes:
1) All Non Current Assets required to be
acquired in connection with the project.
2) Margin on Working Capital
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Project Cost
Current Liability + (Term Liability +
TangibleNet Worth) = Total of Liability Side of
Balance Sheet = Total of Asset Side of
Balance Sheet = Non Current Asset +
Current Asset
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Project Cost
In other words,
Project Cost = Long Term Finance required
for setting up the project
= Non Current Assets + Margin
on Working Capital
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Project Cost
Liabilities Assets
Net Worth 500 Non Current Asset 600
Term Liability 200 Current Asset 400
Current Liab 300
Total------1000 Total------1000
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Project Cost
Margin on Working Capital = (Current Asset
- Current Liability)
= 100
Long Term Finance = Non Current Assets
+ Margin on Working Cap
= 600 + 100 = 700
= Net Worth + Long Term Debt = 500 + 200
Term Loan of SBI is a part of Long Term Debt
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The Complete Process
Company wanting to set up a Project
( a new, an expansion, a modernisation
or a diversification project)
Approaches SBI for a Term Loan
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The Complete Process
SBI examines the DPR (Detailed project
Report submitted by the company).
Check for: 1) Technical Feasibility2) Financial Viability
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The Complete Process
For Financial Viability : -
Employ Capital Budgeting Techniques
( NPV, IRR, Payback Period etc.).
The Project is acceptable only if it is both
Technically Feasible and Financially Viable
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The Complete Process
For Technical Feasibility:
Check (A) The Process
(B) The Installed Capacity
(C) Availability of all Inputs
including Power, Water, Skilled
Labour, Raw Material
(D) Market Demand (Global
Demand Supply Gap; WTO)
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The Complete Process
For Financial Viability : -
Employ Capital Budgeting Techniques
( NPV, IRR , Payback Period etc.)
Any Project is acceptable only if it is both
Technically Feasible and Financially Viable
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The Complete Process
Assuming the Project is acceptable and the
Project Cost is in order, take a look at the
Means of Financing.
Capital Structure for the Project, i.e. howmuch Long Term Debt & how much Equity
are to be used for financing the Project
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The Complete Process
The Project Debt : Equity Ratio may be 1
(i.e. Debt and Equity both at 50% of the
Project Cost) or 1.5 (i.e. Debt at 60% &
Equity at 40%). Besides, a minimum
contribution by the Promoters, say at 15%of the Project Cost, may also be necessary.
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The Complete Process
In case the Project is acceptable (both
Technically Feasible and Financially Viable)
and the Project Cost as well as the Means
of Financing is in order, Bank can go ahead
with processing of the Term Loan Proposal.Check the Debt Service Coverage Ratio.
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The Complete Process
Once the processing is complete, the Bank
can go ahead with issuing a Sanction Letter.
But, NO DISBURSEMENT is to be made
until the Equity contribution is lined up bythe company (The Project can not be set up
only with Term Loan without the Equity).
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The Complete Process
Once the company successfully makes a
Public Issue of Equity and the Project is
otherwise ready for implementation, the
Bank can start disbursement.
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The Complete Process
With the entire Project Finance (Equity as
well as Term Loan) already available, the
company is to implement the project.
Once the project is already set up and the
company is ready for commercial operation,
the company approaches for Working
Capital Finance from the Bank.
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Sources of Finance
Long Term Finance
(Project Finance)Short Term Finance
(Working Capital)
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Sources of Long-term Finance
Share CapitalLong-term Debt
Equity Preference
Domestic InternationalGDR/ADR etc.
Retained
Earnings
(Dividend
Policy)
New Issue
Public Issue Rights Issue
Term Loans
Lease
Rupee Foreign
Currency
(ECB)
Bond /Debenture
International Domestic
Foreign
Currency
Bond
Euro
BondNCD
PCD
FCD
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Sources of Long-term Finance
Share CapitalLong-term Debt
Equity Preference
Domestic InternationalGDR/ADR etc.
Retained
Earnings
(Dividend
Policy)
New Issue
Public Issue Rights Issue
Term Loans
Lease
Rupee Foreign
Currency
(ECB)
Bond /Debenture
International Domestic
Foreign
Currency
Bond
Euro
BondNCD
PCD
FCDINTERNATIONALFINANCE
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IssueofOrdinaryShares
Eligibility Norms
Prospectus to SEBI through an eligible
registered Merchant Banker before filing
with the ROC
Application for listing
Agreement with a registered Depositoryfor dematerialisation
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Public Issue of Shares
Book-building process, with at least
50% allotted to QIBs, 35% to Retail
Investors & 15% to HNIs.
New Guidelines for Book- Built Issues:
QIBs have to apply with 10% marginmoney and there will be proportionate
allotment for them also.
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Issue of Ordinary Shares
Eligibility Norms
Listed Companies: Public Issue
Pricing Mechanism Rights Issues
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Issue of Ordinary Shares
Existing Unlisted Companies
Initial Public Offer (IPO) Newly established Company
No Track Record; In such a case,
Projections be appraised by a Bank,
which must have at least 10%
Exposure.
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Major Steps for Public Issue of
Ordinary Shares
Appoint the lead managers
Appoint other intermediaries, likeco-managers, underwriters, bankers,
brokers, and registrars
File prospectusSend prospectus to brokers
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International Equity Offering
GDR (Global Depository Receipt)
ADR (American Depository Receipt)
Denominated in US Dollars.
1) Why are these necessary?
2) How are they issued?
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International Equity Offering
Process
1. Project to be implemented:
Project Cost; Means of Financing; ProjectCapital Structure
Whether Project is
(a) Technically Feasible &
(b) Financially Viable
2. Necessary Approvals for the issue
(Shareholders approval; FIPB
Clearance, wherever necessary)
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International Equity Offering
Process
3. Appointment of Merchant Banker (s)
4. Drafting of Prospectus
5. Countries where issue to be launched
6. Road Shows
7. Book Building8. Structuring the issue/instrument
9. Actual Issue of GDR/ADR & Listing
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International Equity OfferingGDR/ADR Issue Process
IssuerCompany
DomesticCustodian
GlobalDepository
Ordinary Rupee Shares
Confirmation
GDR/ADR Investors
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GDR/ ADR Investors - Risks
The investors of GDR/ADR have twin risks.
The value of their investments decreases if:
1) The price of the underlying ( Indian ) share
declines.
2) The value of Rupee ( Indian Currency )
aaadecreases vis-a vis the US Dollar.
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DebenturesFeatures
Types of Debentures (NCD,PCD,FCD)
Face Value
Coupon Rate
Periodicity of Payment of Interest Maturity Period / Tenure
Claim on Assets and Income (Creditor)
Interest is Tax Deductible
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Debentures - Features
RedemptionBullet or In Instalment : At
Par or Premium or Discount.
Current Yield & Yieldto-Maturity. RatingEssential, Lowest Acceptable
RatingBBB;
For issues above Rs 100 Croresmore than one Rating is required.
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Debentures - Features
Buy-back (Call Option) and Surrender (Put
Option) provisions
Security - Debenture Redemption Reserve
and appointment of Debenture
Trustee required if Tenure >18
months
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Bonds / Debentures
NCDNon Convertible Debenture
No part of such a Bond / Debenture is to be
converted into Equity Share.
PCDPartially Convertible DebentureA part of such a Bond / Debenture is to be
converted into Equity Share.
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Bonds / Debentures
FCDFully Convertible Debentures
Full face value of such a Bond / Debenture
is to be converted into Equity Shares eitherat one shot or in more than instalment.
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Features of a Bond
1. Face Value - Rs 10002. Coupon Rate - 12% p.a.
3. Frequency of Interest Payment / Compounding
Annual
4. Tenure - 5 years
5. Redemption - Bullet, at a Premium
of 10%
6. Market Price - Rs 1200
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Cash Flow from a Bond
Time Interval Cash Inflow Present Value
end of .y. 1 Rs 120 Rs 120 /(1+r)
,, ,, ,, 2 Rs 120 Rs 120 /(1+r)^2,, ,, ,, 3 Rs 120 Rs 120 /(1+r)^3
,, ,, ,, 4 Rs 120 Rs 120 /(1+r)^4
,, ,, ,, 5 Rs (120+ Rs1220/(1+r)^5
1100)
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Types of Debentures
Non Convertible Debentures
Fully Convertible Debentures
Partly Convertible Debentures
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Convertible Debentures
PartiallyConvertible - Debentures
FullyConvertibleDebentures
These are converted into a specified
number of ordinary shares at
specified points of time.
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Foreign Currency Bond
Foreign currency Bonds
ForeignCurrency
Bond
Floating RateNote (FRN)
Foreign CurrencyConvertible
Bond (FCCB)
YankeeBond ($)
Bull DogBond (GBP)
SamuraiBond (JPY)
Dragon Bond(Hong Kong $)
Domestic Bond
Euro Bond
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A Comparative Chart
Bond Preference Share Equity Share
Fixed Tenure Fixed Tenure Perpetual Security
Pays Interest Pays Dividend Pays Dividend
Interest Rate Dividend Rate Dividend never
pre-determined pre-determined pre-determined
Interest payable Dividend payable Dividend payable
irrespective of only if sufficient only if sufficient
profit profit is available profit is available
(after payment of
preference Dividend)
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A Comparative Chart
5 No ownership No ownership Ownership
No voting right No voting right Voting right
6 In case of liquidation of company,
Bond-holders Preference share Equity share
are paid first holders are paid holders paid
(along with after creditors last (after
other creditors) creditors andPreference
share)